Magazine article The CPA Journal

Tired of Waiting for 59 1/2? You May Want to Try 55

Magazine article The CPA Journal

Tired of Waiting for 59 1/2? You May Want to Try 55

Article excerpt

It is well known that at age 59 1/2 or older the rules with respect to qualified retirement plans and other retirement vehicles (e.g., IRAs) permit the withdrawal of funds without penalty, but that such withdrawals are considered ordinary income subject to a tax based at marginal tax rates. The allure of retirement is so keen that some people seem to be counting the days until they reach the magic 59 1/2 so that they can begin drawing from the tax sheltered plans they have been paying into for most of their working lives. Retiring earlier than that seems to be almost within their grasp due to the significant increase in their investments during the past four or five years from the doubling of securities values in the marketplace.

The 59 1/2 benchmark is spelled out in IRC section 72(t)(2)(A)(i). Withdrawals prior to that age are generally subject to a premature withdrawal penalty, generally a flat 10% of the gross amount withdrawn, in addition to any income taxes that may be payable because of the inclusion of the withdrawal in taxable income. For example, if a person's marginal tax rate were 31%, he or she would end up paying a composite 41% on the total withdrawal.

However, there is a bright spot in the code. If, during or after the calendar year in which an individual reaches age 55, the individual is or was a participant in a qualified employer plan and meets specific qualifications, the early withdrawal penalty may be circumvented. Please note that the following discussion applies only to qualified employer plans and not to IRAs.

Qualified Employer Plans

IRC section 72 notes that the term "qualified employer plan" shall include any plan that is (or is determined to be) a qualified employer plan or government plan. A government plan means any plan, whether qualified or not, established and maintained for its employees by the United States, a state or political subdivision thereof, or by an agency or instrumentality of any of the foregoing.

The term qualified employer plan includes the following:

A trust created or organized in the United States and forming part of a stock bonus, pension, or profit-sharing plan of an employer for the exclusive benefit of its employees or their beneficiaries An annuity contract purchased by an employer for an employee under a plan that meets the requirements of section 404(a)

An annuity purchased by a section 501c(3) organization for an employee who performs services for a section 170(b) educational organization, by an employer that is a state, a political subdivision thereof, or an agency or instrumentality of any one or more of the foregoing.

If an individual can satisfy the qualified employer plan test, then he or she should turn attention to the IRS's Publication 575. The section "Tax on Early Distributions and Exceptions to Tax" reads as follows: "The 10% early distribution tax does not apply to distrbutions that are made to you after you separated from service with your employer if the separation occurred during or after the calendar year in which you reached age 55." This section goes on to note that this provision applies only to distributions from qualified employer plans.

Withdrawals

The amount an individual can withdraw has prescribed qualifications as noted in IRC section 72(t)(2XA)(iv). …

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